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TMI Blog2015 (8) TMI 1437X X X X Extracts X X X X X X X X Extracts X X X X ..... e and Revenue respectively. Assessee in its appeal has altogether taken five grounds of which grounds 1, 2 and 5 are general needing no specific adjudication. Grounds 3 and 4 relate to adjustments done on the pricing of the international transactions undertaken by it. 2. Ld. Counsel for the assessee at the outset submitted that if his grounds seeking exclusion of two companies from the list of comparables that are left after considering the directions of the CIT (A) and seeking inclusion of two companies originally proposed by the TPO but later on rejected by him are considered, then other issues raised relating to transfer pricing, except for the one regarding adjustment of working capital could be adjudicated at a later point of time if and when required. Grievance of the assessee regarding working capital adjustment is restriction thereof to 1.71%. 3. Facts apropos are that assessee a company engaged in the business of providing software design and maintenance service and marketing support had operating revenues of ₹ 85,32,91,086/-. Margin of profit of the assessee on its cost for the relevant previous year was as under : Description (Rs.) Operating Revenues 85,32,91 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ereafter, he made his own study of the above mentioned data bases and found as appropriate 11 comparables listed hereunder which inter alia included the five comparables in the assessee's list : Sl. No. Comparables Selected by TPO NCP Margins as per TPO order (%) (WC - Unadj) 1 Kals Information Systems Ltd 13.89 2 Akshay Software Technologies Ltd 8.11 3 Bodhtree Consulting Ltd 62.27 4 R S Software (I) Ltd 9.97 5 Tata Elxsi Ltd (seg) 20.28 6 Sasken Communication Technologies Ltd 27.91 7 Persistent Systems Ltd 41.40 8 Zylog Systems Ltd 7.81 9 Mindtree Ltd (seg) 5.52 10 L & T Infotech Ltd 24.72 11 Infosys Technologies Ltd 45.61 Arthmetical Mean 24.32 7. Common comparables were Akshay Software Technologies Ltd, Bodhtree Consulting Ltd, L & T Infotech Ltd, Mindtree Ltd (seg) and Persistent Systems Ltd., On the above adjusted arithmetic mean, AO effected a negative working capital adjustment of 1.71% and fixed the PLI of comparables at 22.61%. Adjustment required to be made u/s. 92CA of the Act, was worked out by the TPO as under : Arms length mean margin 24.32 Less : Working Capital Adjustment 1.71 Adjusted mean margin of the comparable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s placed on the decision of coordinate bench in the case of Cisco Systems (India) (P.) Ltd. v. Dy. CIT 66 SOT 82 (Bang. - Trib.)(URO) . Ld. AR also submitted that Bodhtree Consulting Ltd was also held to be a company having extra ordinary profits not suitable as a proper comparable by the coordinate bench in the case of Mindtek (India) Ltd. v. Dy. CIT [IT (TP) A.70/Bang/2014, dt.21.08.2014]. As per the Ld. AR both these decisions were for the same assessment year and therefore could be taken as good precedence for exclusion of these companies from the list of comparables. 12. Articulating his arguments for inclusion of Thinksoft Global Ltd and FCS Software Solutions Ltd, Ld. AR submitted that these companies were proposed by the TPO herself in her show cause notice dt.17.12.2012 and assessee had accepted them to be proper comparable. However, according to him, these were rejected by the TPO giving a reason that working capital adjustment impact was more than 4% of the profits of these companies. As per the Ld. AR, TPO erroneously concluded that these companies were engaged in financing activities, whereas the records speak otherwise. According to him, profit and loss account of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent services segment. Vis-à-vis comparability of Bodhtree Consulting Ltd, this Tribunal held as under at para 26.1 of its order: "26.1 Bodhtree Consulting Ltd.:- As far as this company is concerned, it is not in dispute that in the list of comparables chosen by the assessee, this company was also included by the assessee. The assessee, however, submits before us that later on it came to the assessee's notice that this company is not being considered as a comparable company in the case of companies rendering software development services. In this regard, the ld. counsel for the assessee has brought to our notice the decision of the Mumbai Bench of the Tribunal in the case of Nethawk Networks Pvt. Ltd. v. ITO, ITA No. 7633/Mum/2012, order dated 6.11.2013. In this case, the Tribunal followed the decision rendered by the Mumbai Bench of the Tribunal in the case of Wills Processing Services (I) P. Ltd., ITA No. 4547/Mum/2012. In the aforesaid decisions, the Tribunal has taken the view that Bodhtree Consulting Ltd. is in the business of software products and was engaged in providing open & end to end web solutions software consultancy and design & development of softw ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... der on the issue which is as follows : "Bodhtree : The assessee has objected to selection of this entity on the basis of following objections: • The entity has fluctuating margins • The company is more of a product company rather than software service company. The Panel has considered the objections of the assessee. Insofar as the contention regarding the rejection of this entity on the basis of fluctuating margin is concerned, in order to appreciate the compatibility or otherwise of this entity, it is important to first note that the Indian software industry uses two different models for revenue recognition. The first is the Time and Material (T&M) Contracts model in which Customer are billed on the basis of hours worked by the employees of supplier software companies. Hourly rates are agreed on by both parties and are applied to the total hours worked to arrive at the revenue that is to be recognized. The second is the Fixed Price Project Model (FPP). Under the Fixed Price Project Model, the total contract price is agreed upon between the parties. Billing may be done either at the end of the contract or over the period of the contract on the basis of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... also submitted that as per the annual repot, the salary cost debited under the software development expenditure was ₹ 45,93,351. The same was less than 25% of the software services revenue and therefore the salary cost filter test fails in this case. Reference was made to the Pune Bench Tribunal's decision of the ITAT in the case of Bindview India Private Limited v. DCI, ITA No. ITA No. 1386/PN/1O wherein KALS as comparable was rejected for AY 2006-07 on account of it being functionally different from software companies. The relevant extract are as follows: "16. Another issue relating to selection of comparables by the TPO is regarding inclusion of Kals Information System Ltd. The assessee has objected to its inclusion on the basis that functionally the company is not comparable. With reference to pages 185-186 of the Paper Book, it is explained that the said company is engaged in development of software products and services and is not comparable to software development services provided by the assessee. The appellant has submitted an extract on pages 185-186 of the Paper Book from the website of the company to establish that it is engaged in providing of I T ena ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ware Solutions Ltd, we find that TPO herself had suggested these in the show cause notice, but had thereafter come to a conclusion that working capital adjustment required for these two companies exceeded 4% of profits and could not be therefore taken as proper comparables. Reasons given by the TPO for excluding these two companies, appear at paras 3.6.5.1, of her order which reads as under : "(b) Two companies proposed in the show-cause notice are functionally similar to the taxpayer. However, when the working capital of these companies is considered, the profit margin gets distorted. It may not be out of context to mention that our search for comparable is primarily focus on those companies whose profit margin is predominantly from operating business and not from financial activities. This prerequisite is not different in case of software development companies as they do not need any interest bearing funds to manage their working capital requirement. Therefore, with the purpose to identify only those uncontrolled comparables who are having profit margin from core operating activities and not from financial activities, the following two companies having working capital impa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the TPO in this regard as it appears at para 3.7, reads as under : "3.7 Working Capital Adjustment: The working capital adjustment is computed as per the formula given in Annexure to the OECD Guidelines, 2009. In this case, the average PLR adopted by SBI, the largest scheduled bank, for short term working capital loans for the relevant FY 2008-09 is considered. The average PLR of 12.50% p.a was adopted by the TPO while computing the working capital adjustment. The working capital adjustment is restricted to the average cost of capital computed at 1.71% in the case of the uncontrolled comparables selected by the TPO. Hence, the working capital adjustment in the case of the taxpayer is allowed as per the calculation in annexure-C or the average cost of capital to the comparables whichever is the least. The detailed discussion on this is given in the Annexure-D to the order. The computation of the working capital adjustment is annexed to this order as Annexure C." TPO had restricted the cost of capital to 1.71%. Rationality for such an upper limit being placed on working capital adjustment was an issue which had come up before this Tribunal in the case of Rambus Chip ..... 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